Lowering the Cost of Your Loan: Interest Rates and Repayment Terms

10.24.16

You’re a smart shopper. You spent hours researching all of your options to find the best student loan. The choices are narrowed, and you’re ready to choose, but did you consider all of the variables?

If you’re like most people, you compared interest rates (or APRs) to determine the lowest-cost student loan option. Why wouldn’t you? For decades, we’ve been inundated with interest rate-focused advertising from banks, mortgage lenders, and car dealers. It’s a simple comparison, and the math is already done for you, so it’s natural to stop there.

However, there are other variables you should consider that could reduce the cost of your student loan. In this case, our partners at College Ave Student Loans look at how a shorter repayment period could save you thousands of dollars.

How does a lower interest rate affect the monthly payment and total cost of my student loan?

First, let’s define what we mean by “total cost” of your student loan. The total cost is calculated as the amount borrowed plus any interest charged over the life of the loan.

Total Cost = Amount Borrowed + Interest Charges

Now, let’s look at how a lower interest rate affects the total cost of a student loan. In the example below, this student would pay approximately $8 less per month and save $1,422 over the course of a 15-year loan simply by choosing the loan with the lower interest rate.

However, things change a bit when we add in a few more variables. When we change the length of the loan, the lower interest rate doesn’t have the same effect.

What about a shorter repayment term?

In this next example, the loan with the higher interest rate (7.2%) and shorter repayment period (10 years) is the better option if your goal is to reduce the overall cost of the loan. While it’s true that the monthly out-of-pocket costs will be $42 lower in the scenario with the 15-year term (and lower interest rate), you save more than $1,600 by taking the 10-year loan, even with a higher interest rate.

Why? The value of time works both ways. When you’re saving for a big purchase (like college), we’re told the earlier we start the better, even if we can only afford to save a little at a time. When it comes to borrowing money, the concept is the same, but it works in reverse. A shorter time frame and larger payments drives down the total cost of a loan.